Capitalization Rate (Cap Rate) Calculator
The capitalization rate (cap rate) is a key metric in real estate investing. It represents the ratio between the net operating income (NOI) generated by a property and its market value (or purchase price). A higher cap rate generally indicates a potentially higher return on investment, but it's crucial to consider other factors.
Results:
Enter values above to see the Cap Rate.
Understanding Cap Rate
The formula for capitalization rate is straightforward:
Cap Rate = (Net Operating Income / Property Value) * 100
Net Operating Income (NOI): This is the annual income a property generates after deducting all operating expenses. Operating expenses include property taxes, insurance, property management fees, repairs and maintenance, utilities (if paid by owner), and any other costs associated with running the property. Importantly, NOI does NOT include mortgage payments (principal and interest), depreciation, or capital expenditures.
Property Value: This is typically the current market value of the property or the price at which you acquired it. For investment analysis, it's often the purchase price. For existing properties, an appraisal or market comparison might determine this value.
Interpreting the Cap Rate:
- A higher cap rate suggests a higher potential return relative to the property's value. This might indicate a good deal or a higher-risk investment.
- A lower cap rate might indicate a less risky investment but also a lower potential return. It could also mean the property is in a high-demand area where prices are inflated.
Cap rates are most useful when comparing similar properties in the same market. They provide a quick way to assess the income-generating potential of an investment property.
Example Calculation:
Let's say you are considering a commercial building that generates $75,000 in Net Operating Income (NOI) annually. The asking price for this property is $1,000,000.
Using the cap rate formula:
Cap Rate = ($75,000 / $1,000,000) * 100
Cap Rate = 0.075 * 100
Cap Rate = 7.5%
This means the property offers a 7.5% return on investment based on its NOI and current market value, before considering financing costs.